price discrimination in the airline industry - Fagbokforlaget

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Large discounts were given to firms, who typically buy flexible tickets. Such a firm’sdemand is typically price inelastic. The reason for the large discounts to those firms isthat the firms triggered a Bertrand-like competition between the two airlines: The firmwith the best offer wins the contract, which means that the other firm lose all its revenuefrom that particular consumer. It implies that each airline has a very high own priceelasticity of demand from each of those firms. We know from theory that this may lead toprice close to marginal costs. As we have already describes, competition on price forsome large consumers indeed become very intense.Frequent flyer programsThis arrangement can be interpreted as a kind of quantity discount, and thus as a specialkind of second degree price discrimination. As referred to already, theoretical studiesconclude that frequent flyer programs can result in more loyal consumers and therebyhave an anticompetitive effect. Unfortunately, there are few empirical studies of theeffect of frequent flyer programs. Let us refer to those two studies we are aware of. 9Nako (1992) quantifies the effects of frequent flyer programs on the businesstravelers’ choice of airlines. It is found that such a program has a significant effect onbusiness travelers’ choice of airline. The effect varies between airlines. It is shown thatthe presence of a corresponding airline in the home city of the traveler is of importancefor the effectiveness of a frequent flyer program. If the corresponding airline is notpresent in the traveler’s home city that would make it less likely that the traveler choosesthe corresponding airline on other routes. Such an effect is strengthened by the frequentflyer program.Proussaloglou and Koppelman (1995) model air carrier demand, and identifiesand measures the relative importance of factors which influence air travel demand. Theyshow, among other things, the importance of a carrier’s frequency (number of flights) in a9 SAS in Norway has recently asked MMI (Markeds- og Mediainsituttet) to undertake a questionary surveyof how airline passengers would react to a ban on the frequent flyer program in the domestic market inNorway. They were asked how such a ban would affect their choice of airline on international flights. 42%of those asked that are gold member in SAS Eurobonus answer that they would prefer other airlines thanSAS on international flights. This suggests that the loyalty effect of such a program is substantial.Furthermore, more than half of those asked that have traveled on Eurobonus answer that they would nothave made the trip if they had to pay for it as an discount ticket. This suggests that the consumer surplusaccrued to the bonus flights might be limited.© Steen and Sørgard 22
city pair market and the importance of a frequent flyer program for a passenger’s choiceof airline. They demonstrate in the empirical part of their study the dramatic impact offrequent flyer programs on carrier choice for individual flights. Furthermore, they foundthat these effects are particularly strong among the frequent business traveler.The latter result is of interest. Why should frequent flyer programs be of largeimportance for those who travel most? Note that a typical frequent flyer program is madein such a way that the bonus benefits are non-linear. When the traveler reaches certainthreshold levels, s/he is entitled to some extra benefits from the frequent flyer program.For example, a member of SAS Eurobonus is entitled to becoming a silver member aftera certain number of points earned in one year, and entitled to becoming a gold memberwhen s/he reaches an even higher threshold level. At the highest threshold level themember is entitled to extra service, for example highest priority if the flight isoverbooked. This implies that each traveler has incentives to stay with one carrier, sincethat would lead to a large number of points earned and thereby a chance that s/he canreach a threshold level and receive some extra service.This kind of loyalty program, where the accumulated purchase is of importancefor the benefits accrued to the program, is in text books described as an optimal way tocreate loyalty among its consumers (see Shapiro and Varian, 1998). Seen from a welfarepoint of view, though, such programs are bad. Loyal consumers would lead to less fierceprice competition and thus higher prices. It suggests that not only frequent flyer programsas such, but also the non-linearity in such programs, can have severe anticompetitiveeffects.3.2 Public policy implicationsWe have described some of the effects of the various kinds of price discriminationdevices that are used in the airline industry. The next question is what implications ouranalysis should have for public policy. Let us comment on each of those three kinds ofprice discriminations separately.Versioning is very common in the airline industry. In our theoretical discussionwe have shown that versioning has an ambiguous effect on welfare. The reason why itcan be detrimental to welfare is that the consumers with low willingness to pay are hurt© Steen and Sørgard 23
Page 1 and 2: PRICE DISCRIMINATIONINTHE AIRLINE I
Page 3 and 4: various kinds of price discriminati
Page 5 and 6: If the quality of the good equals Q
Page 7 and 8: As shown in Figure 3, the quality o
Page 9 and 10: consumers’ consumer surplus. Rear
Page 11 and 12: products. This would lead to an inc
Page 13 and 14: A price increase for the group with
Page 15 and 16: Even if third degree price discrimi
Page 17 and 18: The solid line is the demand if the
Page 19 and 20: 3. THE AIRLINE INDUSTRYIn the previ
Page 21: flexible air ticket, labeled C-clas
Page 25 and 26: very intense rivalry on prices. The
Page 27 and 28: When airlines compete, there might
Page 29 and 30: Holmes, T. J. (1989): ‘The Effect

price discrimination in the airline industry - Fagbokforlaget

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